Recent Capital Market Developments in Australia2009Executive SummaryAustralia has been a net importer of capital over the last decade, in contrast to other developed economies of the west. The country’s financial sector was deregulated in the 1990s, resulting in higher foreign capital inflows, mostly from the United States. It has only been about a decade that foreign investments have been allowed into the capital markets and cross-border financial flows have been allowed. Much of the foreign capital inflows into Australia have been in superannuation funds as well as in derivatives in futures and options.
While foreign capital inflows in most other countries are in short term in nature, Australia has had most capital inflows into the infrastructure sector. This does not only benefit the economy in the long term but is also more stable. Besides, capital inflows have been supported by foreign exchange inflows and trading. Also in contrast to most other developed economies, Australia’s financial intermediaries have witnessed moderate growth thus interest rates have not had phenomenally rise that could have led to financial difficulties in the economy. Since the financial sector has had a limited effect on the real economy, seen from the proportion of total employment in the sector compared to the entire economy, the global financial crisis has had a less of a negative impact on the economy.
However, since the capital flows have gone down in general because of the financial meltdown, Australian financial sector has also been hit by the sub-prime crisis and the subsequent global events. But, Australia has been better equipped to handle the crisis than western economies since it has faced regional financial crisis earlier as a result of which the financial sector has been better regulated. IntroductionThe global financial crisis that erupted in 2008 was a result of excessive exposure of global capital in a host of countries that had low interest rates.
Besides the lack of regulations on financial sectors of leading developed economies, excess liquidity in the systems as a result of low interest rates in countries like the United States, the United Kingdom and Japan, undervalued currencies in leading saving countries like China and accumulation of assets in sovereign funds led to over-leveraging of global financial flows that ultimately led to excessive speculative activities that could not be sustained (OECD, 2008).
It began with the sub-prime crisis in the United States, which had its origin in the mortgage market, which, boosted by the low interest rates, had high demand for loanable funds. As a result, banks found themselves over-exposed to credit and many of them were in sub-prime accounts, with low credit rating. Despite the uncertainty of the recovery of these assets, investors continued to buy securities backed by these assets as collaterals.
Similar was the case in other developed markets like the United Kingdom where interest rates had been low since 2000. When these assets began to default in 2007, it led to a spiraling effect on economies as banks were burdened with illiquid assets and the investments that were backed by these fell in value. Global financial institutions, beginning with Merril Lynch in the United States and Northern Rock in the United Kingdom, first reported huge losses in 2007 and ended up with the bankruptcies of mammoth institutions like Lehman Brothers and AIG having to be bailed out by the US government in 2008.
This had repercussions on the global financial system since the global capital markets have been interlinked with multinational financial institutions investing in almost all capital markets that offer returns. In this paper, I will discuss the developments in the Australian capital market that has made it a net importer of capital and the resulting effect of the global financial crisis on the economy. In particular, the mortgage market, the superannuation industry which is dependent on global capital and Australian financial institutions have been affected directly.
The present financial crisis is different from previous financial crises, like the Asian financial crisis of 1997, which were regional rather than global. I will also discuss the response in government policies to the financial crisis.